Attack on Piketty’s Capital Gets it Wrong

Piketty's central theme is not that inequality of the ownership of wealth is going to skyrocket. The central theme is that the 1% already owns a lot of the capital stock, and the capital stock is going to get gigantic relative to the rest of the economy. Whatever the weakness this meg-tome and mega-best seller, there is no denying - the rich are getting richer, the poor, poorer. (And Piketty is not a Marxist.)

Mike Konczal; Jennifer Rankin; Chris Giles; Neil Irwin

May 29, 2014

If you call rigorous economic research on inequality a Communist plot, will it go away?

Chris Giles at the FT just wrotea critique of the data in Thomas Piketty's Capital. Many people will rightfully debate the empirics of what Giles has found, which he believes shows that inequality of the ownership of wealth - how much of wealth is held by the top 1% - isn't increasing, but it's important to understand how it fits into the larger argument.

Their Problem With the Theory

Giles writes: "The central theme of Prof Piketty’s work is that wealth inequalities are heading back up to levels last seen before the first world war."

This is incorrect, or at least badly stated. Piketty's central theme is not that inequality of the ownership of wealth is going to skyrocket. If you look at the text [1], he's somewhat agnostic about this, but it's not determinative. The central theme is that the 1% already owns a lot of the capital stock, and the capital stock is going to get gigantic relative to the rest of the economy.

Inequality expert Branko Milan also tweeted this point, but let's go through it and break down the theory Piketty puts forward. I used three dominos in my Boston Review writeup, and I'm adding a fourth here to make Giles' critique explicit. Let's describe Piketty's argument as four dominos falling into each other:

1. The return on capital is greater than the growth rate. The infamous "r > g" inequality. Meanwhile growth begins to slow, perhaps because of demographics.

2. The amount of capital, or private wealth, relative to the size of the economy will begin to grow rapidly as growth slows. This is the “past tends to devour the future” line. The size and role of wealth of the past will take on a greater relevance to the everyday economy.

3. If the rate of return doesn't fall, or doesn't fall that quickly, the capital share of income will increase. More of our economic pie will go to people who own capital.

4. The ownership of capital is very concentrated, historically and across a wide variety of countries. It is unlikely to fall quickly, much less spontaneously democratize itself, in response to these trends. So the income and power of capital owners will skyrocket.

So right away, rising inequality in the ownership of capital is not the necessary, major driver of the worries of the book. It isn't that the 1% will own a larger share of capital going forward. It's that the size and importance of capital is going to go big. If the 1% own a consistent amount of the capital stock, they have more income and power as the size of the capital stock increases relative to the economy, and as it takes home a larger slice. However, obviously, if inequality in wealth ownership goes up, it will make the situation worse. (It's noteworthy that these numbers Giles is analyzing aren't introduced until Chapter 10, after Piketty has gone through the growth of capital stock and the returns to capital at length in previous chapters.)

The way that Giles could put a serious dent into Piketty's theory through this analysis is by showing that inequality of wealth ownership is falling in the recent past. This is not what Giles finds. He mostly finds what Piketty finds, except in England, where it's flat instead of slightly growing in the recent past.

From the four dominos, we can also see what flaws in the data would make people believe that Piketty's argument is fundamentally unsound. Remember that Piketty has constructed data for each of these trends, not just the fourth one. Piketty and Zucman's data on private wealth and national income, for instance, ishere. But to really dent the theory you need to take down one of the dominos. Most have been fighting about the third one - that either the rate of return on wealth will fall quickly, or that it is determined by institutional factors that are politically created.

But the idea that the ownership of capital will become more concentrated isn't an essential part of the theory. Though obviously if it does grow, then it's an even greater problem.

Notes on the Empirical Arguments

I'm not blown away by the criticism so far, but I hope Piketty responds to the individual issues. Especially what's going on in Britain, because this could be a good learning experience. A few quick points from me, will hopefully have more later. The two major criticisms outside Britain are:

Weighing Sweden

Giles argues that when comparing Britain, France and Sweden, Piketty should weigh by population, instead of equally. Why? Because weighing the countries equally "is questionable, as it gives every Swedish person roughly seven times the weight of every French or British person."

But weighing here, as always, depends on what you are trying to examine. I'd say the variable is the system of laws and economies that produce a consistent output among a group defined by space over time - i.e. the nation-state. And, especially if you want the variable not to be size but different economic systems, you have a collector's set of what Gøsta Esping-Andersen callsThe Three Worlds of Welfare Capitalism between England (liberal), France (corporatist) and Sweden (social democratic). If none of them are producing a fall in wealth inequality, that's a remarkable fact. Weighing them by economic system makes sense. I'd be happy to be convinced otherwise, but Giles makes no such deep argument.

USA Data Missings?

Giles states that "it is not possible to say anything much about the top 10 per cent share between 1870 and 1960, as the data for the US simply does not exist." However, as Matt Bruenigpoints out, since Piketty's book came out there's been significant new work by Emmanuel Saez and Gabriel Zucman telling us exactly that. Check outthe slides, they are awesome. Well respected work that fills in the makeshift gaps Piketty had to use to make the wealth inequality data for the United States in this period. This is a sign of a good work - subsequent work is bearing out its results.

And this new work points to wealth inequality increasing in the United States. Dramatically. Go figure.

[1] Piketty's conclusion from Chapter 10, which is when he introduces inequality in the ownership of wealth: "To sump up: the fact that wealth is noticeably less concentrated in Europe today than it was in the Belle Epoque is largely a consequence of accidentlal events...and specific institutions. If those institutions were ultimately destroyed, there would be a high risk of seeing inequalities of wealth close to those observed in the past....Nothing is certain: inequality can move in either direction....it is an illusion to think that somthing about the nature of modern growth or the laws of the market economy ensures that inequaity of wealth will decrease and harmonious stability will be achieved."

It's fair to say that this isn't the only worrisome sign he points out in the book.

The FT accused Thomas Piketty (above) of errors in transcribing numbers, as well as cherry-picking data or not using original sources. Photograph: Graeme Robertson for the Guardian

Thomas Piketty has accused theFinancial Times of ridiculous and dishonest criticism of his economics book on inequality, which has become a publishing sensation.

The French economist, whose 577-page tome Capital in the Twenty-First Century has become an unlikely must-read for business leaders and politicians alike, said it was ridiculous to suggest that his central thesis on rising inequality was incorrect.

The newspaper concluded there was little evidence in Piketty's original sources to verify his theory that the richest were accumulating more wealth, widening the gap between the haves and the have-nots in Europe and the United States.

In an interview with the Agence France-Presse news agency, the economist said: "The FT is being ridiculous because all of its contemporaries recognise that the biggest fortunes have grown faster."

While the available data was imperfect, it did not undermine his central argument about widening inequality, he said. "Where the Financial Times is being dishonest is to suggest that this changes things in the conclusions I make, when in fact it changes nothing. More recent studies only support my conclusions, by using different sources."

"I have no doubt that my historical data series can be improved and will be improved in the future … But I would be very surprised if any of the substantive conclusions about the long-run evolution of wealth distributions were much affected by these improvements."

In his book Piketty draws on data spanning two centuries and 20 countries to show how the western world is reverting to levels of inequality last seen during the Belle Epoque period of 1871-1914. The findings have won him an audience with Barack Obama's economic advisers and a spot on the Amazon bestseller lists on both sides of the Atlantic.

But it is the French economist's use of UK data that has proved most problematic for the Financial Times.

Chris Giles, the FT's economics editor, who launched the FT's critique, has written that the book's "problems" are most acute for Britain, "where Prof Piketty shows rising concentrations of wealth among the richest since 1980, when his source data does not". While Piketty cited a figure showing the top 10% of the UK population held 71% of national wealth, a survey by the Office for National Statistics put the figure at 44%. Piketty dismissed the ONS survey as "very low quality". The FT has said Piketty seemed rather unaware of UK data.

The newspaper has rejected Piketty's accusations that its work is ridiculous and dishonest. It also defended the ONS Wealth and Assets survey, describing it as exactly the same type of survey – but with a much larger sample size – as the data Piketty preferred to use in his book for the US.

While claims against Piketty have garnered much gloating on Twitter, he has won support from the Nobel prize-winning economist Paul Krugman. "Anyone imagining that the whole notion of rising wealth inequality has been refuted is almost surelygoing to be disappointed," Krugman wrote on his New York Times blog.

Professor Thomas Piketty's Capital in the 21st Century has data on wealth inequality at its core. His data collection has been universally praised. Prof Piketty says he has collected,

"as complete and consistent a set of historical sources as possible in order to study the dynamics of income and wealth distribution over the long run"

However, when writing an article on the distribution of wealth in the UK, I noticed a serious discrepancy between the contemporary concentration of wealth described in Capital in the 21st Century and that reported in the official UK statistics. Professor Piketty cited a figure showing the top 10 per cent of British people held 71 per cent of total national wealth. The Office for National Statistics latest Wealth and Assets Survey put the figure at only 44 per cent.

This is a material difference and it prompted me to go back through Piketty's sources. I discovered that his estimates of wealth inequality - the centrepiece of Capital in the 21st Century - are undercut by a series of problems and errors.

Six days after The Financial Times launched an attack on the data behind Thomas Piketty's much-debated tome on inequality, "Capital in the Twenty-First Century," Mr. Piketty has offered his first detailed response to the newspaper's criticism.

The short version: He doesn't give an inch.

In response to a request from The New York Times to further address the criticisms, which The Financial Times published on Friday, Mr. Piketty, a professor at the Paris School of Economics, wrote that his data were correct, and his conclusions stood: Wealth inequality in Europe and the United States was high in the years before World War I, fell for much of the 20th century, and has been rising sharply again in the past three decades.

How did Connecticut, one of the wealthiest states in the country, get into a budget mess so bad that state workers were forced to solve it? The answer is that Connecticut is one of the most unequal states in the nation.